When The Debt Hits The Fan

Well here we are. The fate of the free markets are being decided behind closed doors. I have an inside seat on the outside of the door and am up to date on what's is happening but I still of course do not now how the market will take any of it. Or if it will take it.

The new key word is " SIV " not SUV but a lot of these characters do drive SUV's on the way to talking about the big troubles with SIV's. These SIV's are investments in mortgage backed bonds. Today the big banks huddle up as they have been non stop for the past week to come up with a general fund to take on the higher quality of these investments. This is not to be taken lightly and we should all be worried that as the market went up recently these guys were in emergency meeting throughout.... And banks don't usually like to put up collateral unless they have a gun to their head. And in this case the Bush administration is the gun.

The commercial market has been struggling with the amount of paper backed by mortgages contracting sharply. Less than $900 billion's worth total now down from $1.18 trillion on Aug 8th. whenever you drop a big economic statistic that is a GROWTH DRIVER for our economy from the trillion mark to the Billion mark you get folks attention and that's just what has happened.

Behind all of this we have the TXU deal coming in today and I am all over this story like grease on bacon... The cents to the dollar look good-- 99 cents almost no discount-- but beneath the covers is where we will find out if this works out-- One danger is that the deal will look too good which would open the door to a flood of the lesser quality debt out there coming to market, banks holding First data debt are watching and hope to sneak $4 to $6 billion into the system late this week or next. Another problem would be if one bank balks today at the meeting and keeps it's loans in house rather than distribute them...

Certainly all eyes will be on The Pierre Hotel in Manhattan and this co announcement on the rescue fund. Since some bonds have not been traded at all since August pricing these is a delicate balancing act to be sure....

Consider the debt window propped open right now by the slimmest of margins.. Big Ben's hand really and from what I have seen of the new Money Printing numbers things are getting quite out of control.
~stoney

Still waiting on my e mails from the Pierre Hotel on the TXU deal but we have some feedback now on the Bailout plan.

Investors for the most part have welcomed the proposal to restore liquidity in the market for debt issued by structured investment vehicles, or SIVs, but they are warning that more detail is needed before it will be clear whether the plan will succeed.

Bank of America Corp., (BAC), Citigroup Inc.(C), and JPMorgan Chase & Co. (JPM) said Monday that they and several other financial institutions had reached an agreement in principle to create a single master liquidity enhancement conduit - a vehicle known as M-LEC.

Once it is up and running, M-LEC will be able to buy qualifying, highly-rated assets from certain existing SIVs that choose to sell to M-LEC.

Selling assets to the new vehicle would help SIVs meet redemptions and keep the asset-backed commercial paper market rolling over.

"If it comes off, it will be a real plus," said Su-Lian Ho, credit analyst at Daiwa Securities in London. "There are no obvious stumbling blocks that spring to mind, and once you have the U.S. Treasury lending its name to a scheme, it opens lots of doors."

>>The answer from the banks is kind of funny when you step back... To solve this problem of too much bad debt they have of course issued new short term debt! The banks involved said this debt will enjoy "various features, including a cushion of support from junior layers of capital and liquidity backstops." These features should make it more marketable than existing SIV debt.

"SIVs have to sell assets to repay liabilities because they don't have 100% liquidity support," said a credit analyst at one London-based fund manager. "By providing full liquidity, it seems that they're effectively converting the structure from a SIV to a straight ABCP conduit."

The banks involved said that they were still determining what assets M-LEC could buy.

"It's very positive first step, but the details on what sort of assets they will buy are sketchy," said a U.K.-based SIV investor. "The impact of the scheme will depend on how discounted the bonds it buys are."

A SIV's portfolio's assets need to be sold above a certain price to avoid realizing losses and hitting triggers that can result in restrictions being placed on the SIV's investment and funding activity.

"The SIVs will want to sell the best assets at prices that don't hit any triggers. I can imagine that those values wouldn't be far off par values - perhaps around 94% or 95% of face value," said the SIV investor. "But most SIVs hold better quality assets that are AAA rated, so they should be hitting that level. The bigger SIVs didn't have bad assets in the first place. They have had a liquidity problem, not an asset-quality problem."

Once again we have the lock down of an entire section of the market even when much of it is triple A rated!

In a conference call earlier this year, analysts at Fitch said that 58% of assets in Fitch-rated SIVS were AAA rated.

Monday, Lehman Brothers credit strategists said they estimated $145 billion of SIV medium-term notes will mature in the next 12 months.

"Thus a $100 billion conduit would likely alleviate much of the near-term liquidity concern and allow a much more orderly sale of assets," they wrote.

But of course what after that? And now we really feel the " WHACK THE MOLE " phenomena as another area of the debt market is bound to get bristled who will rush in then? The banks again? Will they really risk that much of their own capital? And what if they get stuck with much of this, meaning the interest rates they give don't attract enough buyers?

The scary thing is it would only take one bank one series of mark to book mortgage debt at a much lower level than investors thought-- to RE PRICE THE WHOLE INDUSTRY and for the wheels to come off the cart... it's a delicate balancing act and a bit of a Ponzi scheme, just where will they keep shuffling the bad mortgage loans? Who will eventually wind up with them? - It may be us the US taxpayer!

Yep, I guess old stock was right, sub prime no big deal. How many hundreds of billions have central banks injected into the system? Fed cuts ff and discount rate 50 bp's with the markets barely off their respective highs. And the cp mkt is still pretty much closed off the corps. Now the banks are going to bail each other out! Awesome. A mkt that goes up on liquidity alone is a pretty dangerous one. And yet the mkt churns higher everyday, hoping for the fed to bail them out yet again. The IOU just keeps getting bigger, and people just bury their heads in the sand and wait for the fucking fed. Oy vey. I think it is pretty apparent we've seen peak earnings for this cycle. Not calling a top right here, but this week may be unpleasant for some.

Isnt the problem that the AAA stuff isn't really AAA (ie subprimed tranched out, etc) and the models were wrong? That being the case, they became unmarketable because no one knows how to value these.

So, are we hearing that the banks will take the AAA (at face/what discount as mentioned?) and eat the losses since there is general agreement that AAA rated doesn't have the integrity of something that should be rated AAA (ie its rated wrong).

Kind of... The first problem was that the European banks were sold baskets labeled AAA that included 15% bad debt. That bad debt of course was leveraged 10X!

The now problem is decently rated debt is being rejected along with subprime. Can't really trust the agencies Moody's etc, they are all going to be dragged before congress soon.

It's a contagion problem so what they are trying to do with both the fed window and this rescue package is assure investors that they can get at the AAA rated debt... none of this prices in the bad debt or marks it to book... the idea is to hold and hold and get rid of it in drips and drabs when no one is looking. ~ stoney